It is important to understand how personal finance services work to make better, informed decisions (2024)

By Dhirendra Kumar

The other day, in a write-up by the Director of the UCL Genetics Institute, I learned that the SARS-Cov2 virus has thousands of different strains but none appear to be functionally different from each other. This was a surprise because there’s so much talk about this or that strain being more or less aggressive or infective or whatever. Comparing what scientists write to what social media or the news says often leads to such surprises nowadays. This man wrote something else which I found very interesting. He said that in the coming months, the biggest possible cause of the virus evolving some real functional changes would be the vaccines. Change in characteristics is a response to evolutionary pressure and the vaccines would be a big evolutionary pressure, the biggest that the virus has faced so far.

That took some thinking to absorb, but once you understand what he is saying, you realise that it happens to a lot of things. In a stable environment when there is no new kind of input, there is little incentive to change. Moreover, when the change is deliberate the response is to oppose it, to find a way around it. I once heard this story about why in weddings all across the North, the groom rides on a ‘ghodi’ (a female horse) and not a ghoda. The answer is that some king at some point forbade people to ride a ghoda on their weddings because that was something that only a certain class of people should be doing. In response, people started riding a ghodi. That’s a response to a challenge. I say all this not because I’m an expert about viruses or legends of myths of which I know nothing, but about changes in my own area of expertise, which is personal finance.

Over the decades of watching people sell financial products to other people, I have seen this cat and mouse game of changing regulation that try to bring dubious sellers to heel and then the evolutionary pressure of business becoming a powerful motive to finding the way around it. Unfortunately, savers never see this big picture, because few of us think in terms of the motivations of the person or the organisation we are dealing with, we need to have the right mental model of how it all works.

It’s not a waste of time. Savers and investors really need to understand how things work. Banking, insurance, stock markets and mutual funds look like black boxes to most of us. Therefore, we often don’t recognise the motivations and goals of the people we are dealing with. Without a mental model of how things work, one can’t deal with problems that arise. One can’t even recognise problems. I read somewhere that when a car doesn’t start on turning the key, most drivers turn the key harder, putting more pressure on it. Subconsciously, we feel that the turn of the key starts the engine, and turn it harder despite knowing that it’s just an electric switch that turns the starter motor. It’s like pressing an electric switch harder to try and make a bulb light brighter.

When a financial salesperson says that product X is better than Y, what should you think about? The answer is that unless you really understand what X and Y are, don’t think about what X and Y are. Instead think about why he or she is saying so. Think about motives, about how the machinery actually works, what is behind the switch.

Some time back, there was a news (I wrote about it here) that a lot of financial advisers– big brands in financial services–had decided to abandon the business of mutual fund advice and get back to only sales. Why did they do that? It was a response to Sebi’s tougher rules which prevented them from just selling in the garb of advice. They were never interested in giving any advice.

For most of us, personal finance services are a hard thing to form a mental model of, certainly harder than cars. If we understand exactly how a service works, who is the provider, who is the seller, how they make money and how they will try to make more money; and especially where you fit into their scheme of things, only then can we make better decisions.

(The writer is CEO, Value Research)

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